Britcoin: Will Countries Convert to Crypto?
British Chancellor of the Exchequer, Rishi Sunak, has been making headlines today as it is understood he is pushing a major upheaval of the monetary system in the UK, with a digital version of the pound, dubbed ‘Britcoin’ — an official government crypto-currency, otherwise known as a Central Bank Digital Currency (CBDC). In April, Sunak launched a task force to look into ways to boost (and, in truth, revive) the City of London with the use of innovation and technology at the forefront, even tweeting:
So what are CBDCs? Should we be on board with them? And what will they mean for the monetary system?
CBDCs are what they say on the tin: they are digital currencies issued by central banks. They’re sort of half crypto, half normal fiat currency — essentially a digitised version of the currency already in place. Sunak’s ‘Britcoin’ presumably would be a digitised version of the pound. Globally, many central banks are either researching or piloting some form of CBDC (including Sweden, the European Central Bank, and most importantly China — but more on that later). The Bank of International Settlements (BIS) predicts that by 2024, 20% of the world’s population will be living somewhere that uses a CBDC. But the question then is why are states so keen to jump on the CBDC trend?
Firstly, digital currencies are far easier to track. This means governments are better equipped to tackle tax evasion, money laundering, and terrorist financing, as well as providing states with total knowledge of their economy. That information could be used to form more effective economic policies, leading to greater growth and smaller recessions. However, the most important reason for CBDCs is that it protects a country’s monetary sovereignty…kind of. Monetary sovereignty is the power of the state to exclusively control their own currency by defining what counts as legal tender and being able to retire currency if they wish. Crypto is a threat to monetary sovereignty. Take Diem, Facebook’s digital currency that was originally called Libra, as an example. Facebook originally pitched Diem as its way to cut international friction costs, with the value of Diem being tied to a basket of traditional currencies (which is just a mix of several currencies with different weightings). Any Facebook user could send Diem to another user, making cross-boarder transactions super easy. The worry for states with unstable economies is that citizens might start using Diem as their default currency, instead of their states’ currency. If that were to happen, countries would have less power to affect monetary policies — if people aren’t using the states’ official currency, then increasing supply, manipulating interest rates, and all of the standard economic levers will become less effective.
However, the issue does effect the monetary sovereignty of developed countries too. As mentioned, Diem derived its value from a basket of other currencies like the dollar, the pound, yen etc. But if Diem were to become popular enough, the relationship could be reversed — with Diem not defining its value based on other currencies, but other currencies defining their value based on Diem. Bruno Le Maire, a French Finance Minister, argued that if that were to occur, Facebook could dramatically alter the value of a currency by changing the weighting of that currency in the basket: giving monetary power to a private company with no democratic accountability. The hope is that state-sanctioned crypto in the form of CBDC will dissuade citizens from abandoning their state currencies.
I say kind of, however, because states with less stable currencies risk being undermined by another nation’s CBDC. Take Turkey as an example. Thanks to President Recep Tayyip Erdogan’s aversion to high interest rates (and a habit of sacking central-bank governors), Turkey’s national currency of the Lira fell into a bit of a crisis, which led to Turkish citizens moving towards the U.S. dollar — keeping more of their savings in dollars than Lira. If a digital dollar were to be easily available, Turkey citizens mightn’t even just save in dollars, but, in fact, carry out all their transactions in that currency: the dollar could become Turkey’s default currency. An easily accessible, more stable digital currency could replace a less stable state currency, therefore undermining said state’s monetary sovereignty.
The CBDC doesn’t so much benefit the citizens as it does the state. After all, why should I care about the ‘monetary sovereignty’ of my state? Sure, citizens would probably be in favour of better economic conditions potentially brought about by CBDCs, but that will come at the cost of their own privacy. CBDCs are more hygienic than bank notes and coins (which in times of global pandemics, is a great benefit). States may legally require the use of digital currencies eventually, entirely phasing out the physical variant. The biggest advantage of CBDCs for the individual is that they may be cheaper and more accessible. Currently, there is an entire infrastructure of third-party companies that facilitate mobile payment (e.g. Apple or Google Pay). Alongside this, you have commercial banks who act as middle-men between central banks and the individual. These transaction costs cost each person about $350 per year, but if these third-party companies and middle-men were to be removed, and instead the state were to facilitate a direct connection between the central bank and the individual, then theoretically there should be lower transaction costs.
However, as mentioned, CBDCs do have a hidden charge: your privacy. The state would have information on citizen’s economic activities, perhaps leading to a totalitarian dystopia where you receive instant e-fines for what the state sanction to be ‘bad’ behaviour, or limitations on what you can buy.
Take China as an example. China is leading the race to digital currency, and as it is the furthest ahead, gives us a good insight into what the future of CBDCs could look like. In April of last year, China announced a closed pilot scheme for it’s CBDC named the Digital Currency Electronic Payment (DCEP), which would begin in 4 cities. Government workers were reportedly paid 50% of their transport subsidies in DCEP in order to introduce it into circulation. While the Chinese government insisted their was no official timetable, it is clear that China was and still is keen to introduce a CBDC as soon as possible.
The People’s Bank of China has been considering a CBDC since 2014, and the Digital Currency Research Institute (which is in charge of digital currency development and testing) was first inaugurated in 2017, inviting major state-owned commercial banks and other influential institutions to help them in the design of the DCEP system. The DCEP is just a digitised version of China’s currency, Yuan, being tied one-to-one with it. The DCEP works on a two-tiered system — the People’s Bank of China issues DCEP to smaller commercial banks, who then issue digital wallets to customers, who access their wallets via a smartphone app authorised by the People’s Bank of China.
Unlike other Crypto-currencies, the DCEP does not use Blockchain technology, and is far more centralised. But perhaps the DCEP’s most important distinction from regular crypto is that it conforms to a traditional monetary theory of currency. There are two classical theories of money: Metalism (which holds that money derives it’s value in relation to some precious metal such as silver or gold) and Chartism (which holds that money derives it’s value from the fact that it will be accepted from the state as taxation). No state accepts Bitcoin or Dogecoin as tax, and the values of these crypto aren’t tied to any metal (perhaps explaining their volatility). The DCEP, on the other hand, is accepted by the Chinese state as taxation, thus conforming to the Chartist theory of money.
The DCEP works without an internet connection. If the DCEP is truly meant to become China’s replacement for physical currency, it has to work offline for 2 reasons: 1) so it can be adopted in rural communities where internet connections are scarce and 2) so it can still function as a medium of exchange if a technological blackout were to occur, otherwise the economy would crumble every time the internet went down.
As I mentioned earlier, CBDCs are more hygienic than cash, and this was evidenced in China. In the wake of Covid-19, shops in China (and of course, everywhere else) stopped accepting cash due to fear of infection. The Chinese central bank actually destroyed $6 million worth of paper money collected from the worst effected regions for hygiene purposes. Obviously, the DCEP had none of these problems and became a useful alternative for Chinese citizens.
However, the main issue with CBDCs generally, and as was evidenced with China’s DCEP was the privacy issues. At the moment, the Chinese government claims that users have controllable anonymity, and the former Bank of China President said that the technology would allow for some anonymous transactions, adding that there would be limits on the frequency and amounts of money involved. The merger of private data and data held by the state creates what we call the social credit/credit score system, where every aspect of our behaviour is monitored by a central system to score you as a person. This system, which is already active in China, incentivises community work and good deeds, but punishes whatever the state doesn’t like, and if the state doesn’t like you speaking out against them, then your credit score is lowered. How might this effect you? Well the credit score scheme was originally meant to determine whether or not the bank should grant you a loan, but now it is used to make decisions about housing and job applications. Say you are in the unfortunate condition many are in due to the pandemic; you lost your job. Well if you miss a credit card payment because you lost your job, your chances of getting a new job are reduced, and thus you are more likely to miss another credit card payment, and the cycle continues. The DCEP as a CBDC allows China to score citizens with greater accuracy, and punish them more precisely.
Of course, by cutting out the middle-men, CBDCs would also impact traditional banks. Commercial banks work by storing loads of money and then, assuming everyone wouldn’t need their money back all at once, lend money out to other people. This is a process known as fractional reserve banking: only a fraction of a bank’s deposits are backed by actually cash that is available to withdraw, while the rest is loaned (and banks then make a profit from the interest on those loans). Fractional reserve banking sort of fuels the entire economy. If CBDCs remove the need for bank deposits, citizens might just use their state-sanctioned digital wallets to store their money, thus ending fractional reserve banking. Equally, if you currently run a business, you have to pay a card network like Visa or Mastercard. But if the state decides to do this for free, that cuts out the cost.
In truth, the future of CBDCs and how they will effect us is rather unclear. CBDCs are an inevitability — the pandemic has catalysed a cashless society. They certainly have the potential to facilitate illiberal and authoritarian governance, as well as upsetting the financial system as we know it, but whether they are used to do good or bad depends on the government that is enacting them. When it comes to disaster capitalist Rishi Sunak, I have little faith that ‘Britcoin’ will be used for good.
